Tuesday, March 13, 2018

Interview with Jean Tirole: Competition and Regulation

"Interview: Jean Tirole" appears in the most recent issue of Econ Focus from the Federal Reserve Bank of Richmond (Fourth Quarter 2017, pp. 22-27). The interlocutor is David S. Price. Here are a few comments that jumped out at me.

How did Tirole end up in the field of industrial organization?
"It was totally fortuitous. I was once in a corridor with my classmate Drew Fudenberg, who's now a professor at MIT. And one day he said, "Oh, there's this interesting field, industrial organization; you should attend some lectures." So I did. I took an industrial organization class given by Paul Joskow and Dick Schmalensee, but not for credit, and I thought the subject was very interesting indeed.
"I had to do my Ph.D. quickly. I was a civil servant in France. I was given two years to do my Ph.D. (I was granted three at the end.) It was kind of crazy."
Why big internet firms raise competition concerns
"[N]ew platforms have natural monopoly features, in that they exhibit large network externalities. I am on Facebook because you are on Facebook. I use the Google search engine or Waze because there are many people using it, so the algorithms are built on more data and predict better. Network externalities tend to create monopolies or tight oligopolies.
"So we have to take that into account. Maybe not by breaking them up, because it's hard to break up such firms: Unlike for AT&T or power companies in the past, the technology changes very fast; besides, many of the services are built on data that are common to all services. But to keep the market contestable, we must prevent the tech giants from swallowing up their future competitors; easier said than done of course ...
Bundling practices by the tech giants are also of concern. A startup that may become an efficient competitor to such firms generally enters within a market niche; it's very hard to enter all segments at the same time. Therefore, bundling may prevent efficient entrants from entering market segments and collectively challenging the incumbent on the overall technology.
"Another issue is that most platforms offer you a best price guarantee, also called a "most favored nation" clause or a price parity clause. You as a consumer are guaranteed to get the lowest price on the platform, as required from the merchants. Sounds good, except that if all or most merchants are listed on the platform and the platform is guaranteed the lowest price, there is no incentive for you to look anywhere else; you have become a "unique" customer, and so the platform can set large fees to the merchant to get access to you. Interestingly, due to price uniformity, these fees are paid by both platform and nonplatform users — so each platform succeeds in taxing its rivals! That can sometimes be quite problematic for competition.
"Finally, there is the tricky issue of data ownership, which will be a barrier to entry in AI-driven innovation. There is a current debate between platform ownership (the current state) and the prospect of a user-centric approach. This is an underappreciated subject that economists should take up and try to make progress on."

The economics of two-sided platforms
"We get a fantastic deal from Google or credit card platforms. Their services are free to consumers. We get cashback bonuses, we get free email, Waze, YouTube, efficient search services, and so on. Of course there is a catch on the other side: the huge markups levied on merchants or advertisers. But we cannot just conclude from this observation that Google or Visa are underserving monopolies on one side and are preying against their rivals on the other side. We need to consider the market as a whole.
"We have learned also that platforms behave very differently from traditional firms. They tend to be much more protective of consumer interests, for example. Not by philanthropy, but simply because they have a relationship with the consumers and can charge more to them (or attract more of them and cash in on advertising) if they enjoy a higher consumer surplus. That's why they allow competition among applications on a platform, that's why they introduce rating systems, that's why they select out nuisance users (a merchant who wants to be on the platform usually has to satisfy various requirements that are protective of consumers). Those mechanisms — for example, asking collateral from participants to an exchange or putting the money in an escrow until the consumer is satisfied — screen the merchants. The good merchants find the cost minimal, and the bad ones are screened out.
"That's very different from what I call the "vertical model" in which, say, a patent owner just sells a license downstream to a firm and then lets the firm exercise its full monopoly power.
"I'm not saying the platform model is always a better model, but it has been growing for good reason as it's more protective of consumer interest. Incidentally, today the seven largest market caps in the world are two-sided platforms."